InterOil (IOC) is a Canadian gas exploration company that has big licenses in Papua New Guinea (PNG), as well as a refinery and a series of gas stations and distribution centers. IOC is our oldest long which we're still bullish on and which has performed quite well.
After an extensive period of searching for the best partner, enabled by three investment bankers, Exxon (XOM) has emerged as the final bidder, and the company has entered into direct negotiations to supply gas for a third train to Exxon's (nearly finished) LNG plant in PNG.
Central to that deal, and to InterOil's value proposition in general, is the Elk/Antelope (E/A) resource. Without E/A, InterOil would be worth a fraction of what it's worth. Central to the short thesis is the argument that Elk/Antelope isn't what InterOil argues it is. Unfortunately few of the big shorts go on record making this argument, let alone substantiate it.
Whitney Tilson is the exception to this, so when we concentrate on his analysis, it's just because there isn't much else to go by (if one excludes message boards) from reputable sources.
Tilson has been short on IOC for at least five years, and has been quite vocal about it, unlike the great majority of short traders, so we concentrate on his rationale, for lack of other ones. Being short on InterOil hasn't worked out so well over that period. Over time, Tilson has put forward reasons as to why the stock "misbehaved" (that is, refused to plunge as he expected, and still expects); this time is no exception:
In the first half of the year, I saw more pain inflicted upon short sellers than at any point since the internet bubble in 1999 and early 2000. During times of complacency, momentum-focused traders and computer algorithms like to play the "squeeze-the-shorts" game, which can cause heavily shorted stocks to skyrocket.
The funny thing is that some of the longs complain about algorithms from short traders to explain the low valuation and are routinely laughed away by the critics. Let's just say it's difficult to prove either way.
Tilson has been very critical of founder and former CEO Mulacek (and seemed unaware of his departure), but on the day InterOil announced a new CEO, Michael Hession, that became very manifest. Here are some of the characteristics of Mr. Hession:
- Bachelor in geology, PhD in Geophysics, and an MBA
- He has more than 25 years of international exploration, operation and commercial experience, most recently as Senior Vice President at Browse LNG, part of Woodside Petroleum, Australia's largest oil and gas producer.
We're sure it's just a "coincidence" but after seven years of silence on InterOil, out comes Citron's Andy Left, arguing that Mr. Hession was unemployed and just "window dressing." Andy Left isn't the first name that comes to mind for people throwing the first stone (read some of his colorful past here), and he might not have noticed that Mr. Hession resigned from his previous job to pursue other activities, we now know what these are.
Anyway, who is CEO is important, but Elk/Antelope is more important for InterOil's value proposition. Here is Tilson, we have to quote at some length:
I believe InterOil is one of the largest promotions of all time - but unfortunately (so far) for anyone short the stock, it's also one of the cleverest. The company, which has all sorts of associations with questionable characters (and pretty much every other red flag a short seller looks for), has been drilling for natural gas in Papua New Guinea for well over a decade and has repeatedly claimed to have found the mother lode..This valuation is based on the expectation that InterOil has discovered one of the world's largest natural gas fields and that current negotiations with ExxonMobil will result in an extremely lucrative deal for InterOil. I think the odds of this are close to zero.
To be clear, nobody - not InterOil's management nor any outsider - knows with certainty whether the company has a real resource discovery or not. This isn't a fraud like Bre-X (for those of you with long memories) because there really is some gas in InterOil's fields, which makes it almost impossible to disprove the company's claims. Instead, one has to analyze geological reports, look at the track record of the company's promises, examine the background of the key people, and then apply common sense.
This is really extraordinary in many respects. For starters, IOC is not claiming to have found "one of the world's largest natural gas fields." As it happens, Elk/Antelope has been independently vetted by three different specialist companies. One, from Knowledge Reservoir after Elk 1,2,4 and Antelope 1 were drilled; a Gaffney Klein report after the next well (Antelope 2); and the official yearly resource evaluations from GLJ from Canada, the latest earlier this year after Antelope 3 was drilled and evaluated.
Since GLJ is the official resource report, it's the most up to date (including all wells) and Canadian companies can't publish anything besides their official resource evaluation reports, we stick to that one. The first report (2009) on the resource is published in its entirety online, not all companies do that, it has to be stressed. The latest (2013) GLJ evaluation, numbers used until December 31 2012:
|Initial Recoverable Sales Gas (Tcf)||6.83||9.07||10.85|
|Initial Recoverable Condensate (MMbbls)||111.5||135.4||156.3|
|Initial Recoverable (MMboe)||1,250.1||1,646.3||1,965.4|
In fact, InterOil has another gas and liquids field, Triceratops. While appraisal is in early stages, it was enough for Pacific Rubiales (PEGFF.PK) to take a 10% stake in the PPL237 license area. And the comments from them about the prospects in PPL237 area on their analyst day:
We got really a very good discovery and I think that we'll be ready to monetize that. We understand that there is some sort of a beauty contest now between the majors to acquire those positions and we have a tagalong. So we will be able to make a new rapid cash on that property.. In Papua New Guinea, the opportunities that we have interpreted and mapped are very, very, very large. We are talking about in excess of 5 to 10 tcf every single opportunity there.
We have to stress that Triceratops is much less appraised compared to Elk/Antelope and that GLJ assigns only a fraction of the gas and liquids it assigns to Elk/Antelope, yet it has another oil & gas company put up real dollars ($112M to date) for a stake. Now consider the following:
- GLJ is one of Canada's premier resource evaluators
- Tilson doesn't quote any other resource evaluations
- Tilson has no background in oil & gas
- ALL well data are produced by reputable companies like Weatherford, SGS and Schlumberger
And he's not just questioning the numbers, he is questioning the existence of the resource:
To be clear, nobody - not InterOil's management nor any outsider - knows with certainty whether the company has a real resource discovery or not.
Here are some of the well data, we'll leave it up to your imagination whether wells with these kind of characteristics form a "real" resource discovery. Wells with 1000-2000ft of net pay aren't something you drill into every day:
Column Height, ft
|Feet Of Net Pay||Net To Gross||Average Porosity|
Exxon seems to think there is a real discovery here as they wouldn't let InterOil announce them as the winner of the bidding process if it thought there was any change there isn't a real resource in Elk/Antelope. Pacific Rubiales seems to think there is a real discovery in the much less appraised Triceratops field.
It's simply extraordinary what many of the shorts are claiming without providing any basis for their claims. For these claims to be true, we are forced to assume stuff like InterOil forging well data from Schlumberger and Weatherford without them giving a peep, GLJ accepting the forged data, a host of investors like Chandler (who has a 17% stake), American funds and Wells Fargo to be duped in the process, not to mention the PNG government, the three IB companies involved in the sell-down process, Exxon, Pacific Rubiales, the analysts following the company, etc., etc.
Official resource evaluations are normally accepted as fact, with the proviso that the status of these reports is that they are the best estimates with the available data, although new data or actual production can change these. However, these data are not questioned without any basis.
Even the Gaffney Cline report, which is older and doesn't include the last (very successful) Antelope 3 well, while providing a lower estimate (6.6Tcf), but this is still enough for at least a single train LNG plant and very likely two trains.
We're not aware of a single case in which resource numbers are questioned without data or grounds. But Tilson doesn't do just that, he questions the whole discovery! He goes considerably further than even Barry Minkow (now back in jail again for securities fraud). The latter hired a geologist (Bertoni) who wrote a report on Elk/Antelope. The conclusion from Bertoni at the time was that it needed more appraisal (and those conclusions were subsequently "misused" by Minkow).
That conclusion was actually fair at the time, as only one well was drilled in Antelope, which is the structure that contains most of the gas. This leads us to the only kind of rationale Tilson put forward for his thesis, there isn't a deal yet.
Indeed, but rather than assume that there isn't a real resource, forcing us to assume massive fraud implying multiple reputable parties, this can be easily explained by some history. First, it's important to realize that the big Antelope wells, which are the ones confirming the existence of a reef (high quality resource rock), are a relatively recent discovery.
And it's quite unlikely that any party would have committed billions of dollars for an LNG plant on the basis of a single well. So it's simply a bit of a semantic trick (the likes of which we have seen so often) to argue that InterOil has been drilling and promising deals for years and years.
Realistically, one could only have expected serious interest after a couple of Antelope wells were drilled and evaluated by a third party. That's only a couple of years. During those years, InterOil planned for monetizing of the resource with a floating LNG facility and a modular plant from EWC of Australia. However, this ultimately didn't meet approval of the PNG government, causing much delay.
One might also appreciate the fact that multi-billion dollar deals, finding the best partner and negotiating and concluding a deal is not something that is done on a Saturday afternoon. These are protracted processes which can easily take years.
Or we could simply argue that Tilson is short in InterOil for more than five years, that's at least twice the period without success than one could reasonably have assumed InterOil having concluding a deal in. In that time, Tilson hasn't changed his stance whilst InterOil has drilled two more successful wells in Elk/Antelope, greatly reducing any scope to doubt the official resource estimations, but apparently not for Tilson.
Another plank of the short 'thesis' is that (without providing names nor details), he casts doubt on the background of some of the people involved and argues there are many 'red flags' (without even mentioning a single one).
Perhaps he should look in the mirror. We could point out that he has changed the name of the fund twice (from Tilson to T2 when Glen Tongue joined, then to KASE when T2 was disbanded), yet he keeps the same "inception" numbers, yet the other T2 funds (there were three) that started in July 2004 "disappeared."
He would be all over that sort of "accounting" if he was short the fund. He also lists his monthly performance vs. the S&P, yet he never lists the 1,3,5 and 10 year numbers that are the standard of the industry. Enough said.
Whitney Tilson takes the unprecedented step of not just questioning official resource numbers from a reputable third party resource evaluator, he questions the whole resource. He does this without having a background in the industry, without any corroborating data or information, without citing sources, and the acceptance of his 'thesis' forces the reader to assume that multiple reputable organizations are implicit in fraud.
This really is extraordinary. But he doesn't even stop there, he purports to know the right interpretations of the ongoing negotiation process between Exxon and InterOil. Apart from the scarce public statements from InterOil about this process, there isn't any information on these negotiations and Tilson doesn't provide any source, not even a rationale for his interpretation.
All this is rather extraordinaire, we have to say. Perhaps it's no wonder the market has moved against him on this stock. Tilson is entitled to his opinion, but as long as he is unable and/or unwilling to provide any data, information, or sources that back it up, it's just an unsubstantiated opinion.
The substance part is on the other side of this trade. Independently provided well data, resource evaluations, and parties putting up real dollars and engaging in serious negotiation argue that there is a real resource there after all.